Bank Whole Loans Need To Be Marked Properly

I don't know If I find this piece about Merton and Scholes and marked to market accounting interesting, ludicrous or ludicrously interesting, considering that they oversaw the total collapse of LTCM in 1998 or even more recently with Platinum Grove Asset Management, that froze investor withdrawals in late 2008. Whatever it is I find it a little disingenuous that they are railing against Wall Street after they really have no more skin in the game.

But its still nice to hear the truth every once in a while.

www.bloomberg.com/apps/news?pid=20601109&sid=arI9M7cuFWjI"

The basic premise here is that the banks want to place their own inflated prices on their crap loans, because pricing them to market leave them insolvent and thus they cant hand out fat bonus payments to their minions.

The Bank argument is:

That a mortgage loan for which it continues to receive regular monthly payments is not impaired and does not need to be written down. A potential purchaser (Investor) of the loan, however, is unlikely to value it at its origination value. The purchaser calculates a loan-to-value (LTV) ratio using the current, much lower value of the house. After calculating the likelihood of default, the potential buyer/seller (Sec Mkt) works out a price balancing the risk of default and amount that might be lost, a price well below the carrying value on the bank’s books.

The bank is likely to ignore this offered price, or trades of similar assets, with the claim that unusual market conditions, not a decline in the value of the assets, causes a lack of buyers at the origination price. The real motive hear is to avoid a loss at all costs. Yet, by keeping assets at their origination value, the bank creates the absurd possibility that its traders could buy an identical loan more cheaply and so carry two identical securities in the same not for sale account at vastly different prices.

Financial assets, even complex pools of assets, trade continuously in markets. Some trade more then others. Markets function best when companies disclose valid information about the values of their assets and future cash flows. If companies choose not to disclose their best estimates of the fair values of their assets, market participants will make their own judgments about future prices.

All in all, banks don't want anything to do with the truth, because the truth hurts profits.

I have written about market to market accounting and FASB.
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